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Industrial Markets Outlook:The Search for the New Normal Speech to AMT GLOBAL FORECASTING and MARKETING CONFERENCE Eli S. Lustgarten Senior Vice-President, Longbow Securities OCTOBER 20, 2010
WHAT WE SAID IN 2009 APPEARS TO BE TRUE • OUR VIEW: THERE’S 2010 AND THERE IS THE RECOVERY • 2009 SEVERE RECESSION WITH 1H09 GLOBAL ECONOMY REALLY UGLY • U.S.PMI PLUMMETTED AS DID EUROPEAN AND CHINA PMI • CREDIT FINANCIAL CRISES MET WITH MASSIVE STIMULUS PROGRAMS • BOTH HERE (U.S. $787B, TALF,TARP) AND • ABROAD (SOUTH AMERICA $775B; EUROPE/AME $900b; ASIA PACIFIC $850B) • RECESSION LIKELY ENDED MID 2009 FOLLOWED BY MODEST RECOVERY • 2010 MOST LIKELY A TRANSITION YEAR • MFG.CAPACITY UTILIZATION OF AROUND 70% WELL BELOW NORMAL • 2010 WILL FAVOR SHORT CYCLE/PRODUCTIVITY SPENDING • FASTER RECOVERY OF TECHNOLOGY,COMPONENTS AND CONSUMABLES • BULL-WHIP EFFECT IS KEY DRIVER-RECOVERY OF PRODUCTION AND SUPPLY CHAIN FROM VERY DEPRESSED LEVELS • 2011 ECONOMIC OUTLOOK DEPENDENT ON REAL GROWTH IN DEMAND • 2011-2012 SEARCH FOR NEW NORMAL LEVEL OF DEMAND • MOST MARKETS WON’T RETURN TO RECENT 2006 to 2008 PEAKS • 2006 WAS PEAK FOR HOUSING, AUTO, TRUCKS, CONSTRUCTION EQUIPMENT
GREAT GLOBAL RECESSION APPEARS TO BE OVER • Great Recession likely ended in June/July 2009 followed by a gradual economic recovery • Strong growth in China, India, and Brazil leading global economic upturn • U.S. is generally positive with clear strength in manufacturing • Europe and Japan show signs of slow economic growth • Numerous concerns which may lead to volatility in world financial markets • Uncertain financial stability of Sovereign Nationals, particularly Greece, Portugal, Spain, and Ireland; • Even in the U.S. there are rising concerns about Fannie/Freddie and State Financial conditions e.g. California, New York, Illinois • What is the exit path for all the fiscal/monetary stimulus • Concern over Bank exposure to commercial real estate • Domestically, economy being driven by: • Capital goods markets leading the U.S. recovery with the manufacturing ISM Purchasing Managers Index (PMI) showing a strong “V” shaped recovery • Inventory change has become a key contributor to GDP growth • Residential markets are sluggish since incentives have expired • Sentiment has improved modestly across the U.S. economy • University of Michigan 2010 Consumer Sentiment survey rose to 76 in June before falling to 67.8 in July, up to 69.8 in August, down to 68.2 in Sept. and 67.9 in October. • Small Business Optimism Index between 87 and 92 in 1H10 (Sept. 92.9;Oct 87.5)
U.S. ISM PMI HAS SEEN A SHARP RECOVERY BUT STARTED TO PULL BACK FROM HIGHS
GDP REVISION SHOWED WEAKER ECONOMY BUT SAME END TO RECESSION Economy was weaker over the past three years driven by weaker housing and consumer spending. • But recession likely still ended in Mid-2009
Productivity is STRONG coming out of recessions
PRODUCTIVITY GAINS HAVE BEEN SIGNIFICANT SINCE 2Q09 DRIVING 2009-2010 EARNINGS SURPRISES • Productivity usually weak in a recession • Productivity improved since 2Q09 while costs plummeted
IMPROVED PRODUCTIVITY SEEN IN PROFITABILITY REBOUND • Increased productivity evident in strong operating margin rebound for many companies, post 2009 restructuring • Margins for many are approaching 2008 levels, though absolute earnings well below prior peaks due to lack of revenue recovery • In 2009 temporary (zero bonus pay-outs, furloughs, pay reductions, travel restrictions, eliminate overtime) and structural measures (layoffs, plant consolidations and closings, increased automation ) used to reduce costs • Structural measures will continue to offset the return of temporary costs savings (about 60% of costs). • Employee compensation (base wages, healthcare) likely outpaces inflation, hiring will be kept in check
U.S. ECONOMIC OUTLOOK: Recovery Beginning REAL GDP SLOW GROWTH • CAPITAL SPENDING TO SLOW
U.S. ECONOMIC OUTLOOK: (CONT’D) MANUFACTURING OUTPUT STARTING TO RECOVER: • INFLATION PRESSURES FURTHER SUBSIDE:
IMPROVING OUTLOOK FOR GLOBAL GROWTH BUT 2011 GROWTH MODERATING *SOURCE: IMF 1010
VIRTUALLY EVERY INDUSTRIAL END MARKET WAS UNDER PRESSURE IN 2009 Virtually every end market faced lower demand in 2009. Housing fell over 30% to about 900,000 starts in 2008 and is still looking for a bottom. Housing suffered another 40% decline in 2009 to about 554,000 with stabilization now occurring Auto outlook remained ugly with 2008 production about 12.6 million falling to about 8.5 million in 2009 as the automotive bankruptcies were offset by the cash for clunkers auto program. Construction equipment sales and production in 2008 were down 22% to 24% with 2009 now down at least another 45% to 50% as export sales wane and non-residential construction spending falls about 5% (down 11% private and up 3.5% public) in 2009 and likely a similar amount in 2010. The heavy truck sector saw a decline in production to about 205,000 in 2008 compared to 212,000 NAFTA shipments in 2007, while the decline medium truck (class 5 to 7) was 25% from 206,000 to 157,000 units. The lack of credit, the recession and favorable reviews for the 2010 engines eliminated any emissions related truck pre-buy with 2009 falling another 43% to about 118,000,units with a similar decline in the medium truck sector. There was, however, an Engine pre-buy because of rising prices. Global steel demand plummeted 8% in 2009 after falling 1% in 2008 with developed economies particularly hard hit: -36% U.S., -26% Japan, -29% Germany; though China, the largest producer, grew 14% in 2009.
SLOW INDUSTRIAL CAPACITY UTILIZATION RECOVERY IN 2010 We have dug a deep hole to climb out of in 2010 and 2011 Manufacturing Capacity Utilization is now in the Low 70’s compared to more normal 78% to 80% Virtually Every Industrial Sector is Currently Over-Capacitized Globally
2010 WILL FAVOR SHORT-CYCLE, PRODUCTIVITY & EFFICIENCY LITTLE NEED FOR CAPITAL EQUIPMENT FOR EXPANSION IN 2010 Need to absorb excess capacity Only exception may be for new products Production increases mostly related to end of inventory liquidation; production level will more closely match end market sales Smaller, lighter equipment likely to outperform heavy equipment which could decline through 2010 2010 WILL FAVOR ENERGY EFFICIENCY, AND PRODUCTIVITY ENHANCEMENT FASTER RECOVERY FOR TECHNOLOGY, COMPONENTS (MRO AND INVENTORY RESTOCKING) AND CONSUMABLES AS INDUSTRIAL PRODUCTION RISES LENGTH OF BULLWHIP EFFECT IS KEY
CURRENT ECONOMIC DATA IS MIXED: FOR NOW ITS SLOWER GROWTH NOT DOUBLE DIP THE POSITIVES A Major upward revision in personal saving rate coincided with a sharp decline in overall financial obligations as a percentage of disposable income suggesting that the consumers are in better shape than suggested by earlier data The savings rate peaked at 7% in 2Q09 and remained above 5% all year 1Q10 savings rate was 5.5%; 2Q10 was 6.2%; July 5.7% and August 5.8% We are seeing decent real growth in 2Q10 GDP data in disposable income (4.4%), excellent growth in exports (9.1%) and business spending for equipment and software (24.8%) THE NEGATIVES 2Q10 growth in housing (25.7%) and state and local government spending (0.6%) is clearly temporary. Consumer confidence indexes are consistent with stagnation in real consumption Housing still mired at low levels of 8 months ago falling back after end of new buyer incentive programs New $26 B emergency legislation being passed to fund state and local governments to prevent /limit layoffs—($16 B to fund Medicaid obligations and $10 B for teachers’ pay) The current high level of inventory growth ($68.8B ) is likely temporary; Poor July jobs reports with only modest August gains continues trend of slow recovery in employment
THE CONSUMER IS STILL RELUCTANT AND UNLIKELY TO LEAD CONSUMER SPENDING REMAINS SLUGGISH PERSONAL CONSUMPTION EXPENDITURES: • LACK OF CONFIDENCE IN THE ECONOMY; Even the FED is concerned • CHANGING CONSUMER SPENDING PATTERNS • “just drop off the key, Lee, and set yourself free”-Paul Simon • Apple up 94%; Starbucks 61%, Mercedes 25%--splurge in hi-end electrics • P&G struggling as consumers cut back name brand shampoo and toothpaste; • Dollar stores instead of Target
JOBS OUTLOOK: NO PENT UP DEMAND ANYWHERE • JOBS OUTLOOK STILL GOING NOWHERE • Private sector gains of 64,000 in September, a slowdown from 93,000 in August and 117,000 in July • Overall number negative 95,000 reflecting 159,000 decline in Government jobs of all levels • Flat hourly wages at $22.67 • BUT SOFTNESS BENEATH THE SURFACE • Length of work-week barely budged in 6 months • Number working part-time continues to climb • 6,000 shrinkage of manufacturing jobs in Sept Vs. 28,000 decline in August; is uptick in Manufacturing over? • Unemployment at 9.6%, but under-employment rises from 16.7% to 17.1%
A SLOWING OF MANUFACTURING MAY LIE AHEAD September PMI of 54.4 compares to 56.3 in August, 55.5 in July, 56.2 in June, 59.7 in May, 60.4 in April, 59.6 in March, 56.5 in February and 58.4 in January Orders of 51.1 in Sept, 53.1 in August, 53.5 in July, 58.5 in June, 65.7 in May and April, Production 56.5 in Sept.,59.9 in August, 57 in July,61.4 in June, 66.6 in May, 66.9 in April Employment 56.5 in Sept.,60.4 in August, 58.6 in July, 57.8 in June, 59.8 (May), 58.5 (April) Inventory 55.6 in Sept., 51.4 in August, 50.2 in July,45.8 in June, 45.6 (May), 49.4 (April) Customer Inventories are still low at 42.5 in Sept.,43.5 August, 39 July,38 in June, 32 May Ratio of Sept. production/Inventory of 1.02 (vs.1.16 in Aug) and orders/inventory of 0.92 (vs.1.03) continue to suggest an ISM PMI remaining over 50 but slowing. Auto Sales are up (sensitive to incentives) but stabilizing resulting in likely lower 2H10 production levels with potential for schedule reductions in 4Q Global PMI continuing to Improve in Europe even with Sovereign Debt Issues; Euro 10% rebound has quickly eliminated short-term currency advantage for their exports China Growth continues but showing signs of slowing; PMI rebounds to over 50 in August
HOW MUCH LONGER WILL THE BULL-WHIP EFFECT CONTINUE Domestic manufacturing plummeted in the fall of 2008 as industrial production turned sharply negative Capacity utilization dropped to the mid 60’s from near 80% ISM PMI index plummeted to a low of 32.9 in December 2008 European PMI bottomed at 32.5 in February 2009; China was also down significantly Manufacturers underwent an unprecedented inventory liquidation hitting a record $162B annual rate in the second quarter of 2009. THE BULL –WHIP (Forrester Effect): In heavier industries, the at least one-third drop in sales in most markets caused Production to decline by over 50% as inventories were sharply reduced Causing 50% to 75% or more declines in purchases of raw materials and components. The positive BULL-WHIP effect began in late in 2009 and with earnest in F2010 Industrial companies are trying to raise production and stabilize their supply chain much higher levels than the trough of 2009 but well below production levels of 2006 to 2008. CAT: flat 2010 sales would result in a 10% to 15% production increase and a 30% to 40% increase in supplier purchase Note: CAT’s sales are projected to rise 25% in F2010. It appears that the bulk of the BULL-WHIP effect will taper out in 2H10 most likely by the fourth quarter
SLOW CLIMB BACK TOWARD MORE NORMAL DEMAND Real growth in demand will most likely be the driver of economic growth in 2011 Supply chains will likely have been stabilized by 2011 Focus is to improve Factory Thru-put to reduced field inventories Companies employ lean techniques striving to operate with reduced inventory levels compared to history Impact of Government stimulus program will wane without a new round of incentives Congress has bipartisan bill supporting extension of accelerated/bonus depreciation rules set to expire at year end 2010. Proposed 1 year write-off of Capital expenditures would bring demand forward in 2011 at expense of 2012 Key risk is government policy mistakes Will movement to “Re-Shoring” effect to reduce the length of the global supply chain have a material effect?
2011-2012: FINDING THE NEW LEVEL OF NORMAL DEMAND New more NORMAL level of demand perceived to be lower than end market demand realized in 2006-2008 Auto unlikely to return quickly to 16 to 17 million car sales that prevailed from 1999-2005; perhaps 12.0 million to 14.0 million is the new norm; Housing unlikely to return quickly to 2 million starts; New norm may be 1.3 to 1.6 million over the next few years with cautious funding keeping starts below 1 million at least through 2011. Truck market likely to return to more normal levels of demand as early as 2011 e.g. class 8 trucks in the 175,000 to 225,000 range. Prior level peaks of over 300,000 unlikely until at least the next emission cycle; Construction and mining, engines and turbines, railcars and other heavy equipment face a slow recovery through 2012 to levels likely below 2006 to 2008 Steel production follows heavy equipment and infrastructure spending with slow recovery through 2012 Electrical markets probably resume growth post 2010 driven by improving capital spending trends and the initial recovery of both residential and non-residential markets. Energy/Alternative Energy markets await resolution of Government policies and priorities to resume growth. Farm equipment end market demand growth dependent on global economic growth, global demand and weather. Growth likely in 2011 as recent global weather issues in the Northern Hemisphere have offset the risks associated with the potential of large global crops depressing commodity prices.
Farm Equipment GLOBAL WEATHER PROBLEMS REDUCE DOWNSIDE RISKS
SPRING DATA SUGGESTED LARGE CROPS BUT RECENT WEATHER MAY PUSH PRICES HIGHER Source: USDA WASDE May 2010
FARM CASH RECEIPTS ARE STILL NEAR RECORD LEVELS Source: DEERE & CO
ATYPICAL JULY/AUGUST 2010 WEATHER CHANGES OUTLOOK FOR COMMODITY PRICES Weather concerns about current harvest in some key Northern Hemisphere regions have driven recent global Ag commodity price significantly higher Global wheat and coarse grain production according to the International Grain Council (IGC) has been reduced by 23 million tons from a previous near-record 1,782 million to 1,753 million. Grain crops have been significantly affected by the adverse July weather in parts of the Black Sea region, the EU and Canada The impact has been mostly in the northern hemisphere wheat and barley crops in which projections have been lowered by 13 million and 7 million tons respectively. Reduced grain crop prospects have also reduced consumption forecasts, mainly feed, resulting in a reduced projection for 2010/2011 global consumption to increase 0.8% to 1,774 million tons. (prior forecast for 2010/11 was 1,781 million tons, up 1.1% from 1,761 million in 2009/10)) With global crop forecasts reduced more than consumption, 2010/2011 world carryover stocks for grain are now projected by the IGC to be 18 million tons lower to 369 million tons. This is 21 million tons below the 2009/2010 carryover of 390 million, but FLAT with the 2008/09 carryover of 369 million tons. Global supplies are viewed by the IGC and most Ag economists to be ample.
COMMODITY PRICES JUMP ON WEATHER FEARS …Corn Prices follow…. Wheat Prices Soar on Weather Fear in Northern Hemisphere… …As do Soybean Prices.
FARM EQUIPMENT OULOOK FOR 2010-2011 IS IMPROVING 2010 Outlook Modestly Improving 2011 Outlook Now for Moderately Higher Equipment Sales – Up 5% to 15% or More Globally
ETHANOL MANDATE MAY BE HIGHER THAN MARKET CONDITIONS CAN SUPPORT • Renewable fuels mandates per EISA 2007—2011 CORN STOCK TO USE RATIO PROJECTED AT 6.7%--2ND LOWEST ON RECORD
Power Generation STILL IN DESPERATE NEED OF AN ENERGY POLICY
WIND FACES UNCERTAIN GROWTH IN 2010 • WITH FAVORABLE STATE AND FEDERAL POLICIES • US wind sector on path for 165GW of installed capacity by 2025 • Total wind capacity would be about 200 GW representing about 5% of US energy sources. • NEAR-TERM POLICIES CREATE UNCERTAINTY • Problems include Transmission congestion and fall electrical demand • Need Coordinated NATIONAL Transmission policies and National Renewable Energy Policy/Federal Energy Policy • BIG CAPACITY ADDITION DROP LIKELY IN 2010 FROM 9,922MW IN 2009 • Only 500MW installed in 1Q10 • Only 700MW installed in 2Q10
CLEAN ENERGY, JOBS, AND OIL COMPANY ACCOUNTABILITY ACT • NEW SENATE BILL INTRODUCED AT END OF JULY • NO CAP ON CARBON EMISSIONS FOR ELECTRIC POWER SECTOR • NO RENEWABLE ENERGY STANDARD (RES) WITH 15% TARGET BY 2021 • China wind/solar low carbon technology investment is currently $11.9B compared to $4.9B in the U.S. and $4.5B in Europe • 28 states and District of Columbia have RES targets that are higher than 15% TARGET missing from the Senate Bill
Automotive THE UGLINESS IS OVER; FOR NOW ITS JUST UGLY
SOURCE:DESROSIERS AUTOMOTIVE CONSULTANTS
AUTO INDUSTRY FACES SOME DIFFICULT YEARS European build 2009: 15.9 Million, -25% 2010: 16.9 to 17.5 Million 2011: 17.5 to18.5 Million
SLOW RECOVERY FOR APPLIANCES KEY DRIVERS: HOUSING, JOBS AND CONSUMER BEHAVIOR
KEY DRIVERS OF APPLIANCE SALES • New housing completions • Existing home sales • Unemployment rate • Growth in replacement demand • Consumer spending and income
STATE OF THE APPLIANCE INDUSTRY 2009 • CORE APPLIANCES — 36,848,000 TOTAL UNITS • REFRIGERATION 28.3% COOKING 17.1% • LAUNDRY 39.9% DISHWASHERS 14.7% • DOLLAR VALUES • REFRIGERATION $8.2B • SIDE BY SIDE $2.5B; TOP FREEZER $2.6B • BOTTOM FREEZER $2.4B; FREEZER $0.7B • LAUNDRY $8.1B • WASHERS $4.6B; DRYERS $3.5B • COOKING $4.9B • DISHWASHERS $2.4B